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Reader Profile

Peter G. Peterson
Chairman and Co-Founder
The Blackstone Group

Editor's note: Each month, we ask a Directors & Boards reader to comment on critical issues facing directors today. If you'd like to participate in this section in the future, please email Scott Chase.

What do you believe that Boards of Directors should be most concerned about?

I guess I worry that some combination of continuing corporate scandals and legislative hyper-activism might lead to some misdirected legislative “solutions” to executive compensation.

History teaches us the sad fact that Congressional action, particularly in the area of executive compensation, often has serious unintended negative (and sometimes ironic) consequences and rigidities. We observed these negative consequences when Congress placed a cap of $1 million on cash compensation deductibility, inadvertently setting off an explosion in awards of fixed-priced stock options and rapidly inflating senior compensation in the process. This kind of unfortunate Congressional involvement is the political equivalent of what the medical profession calls the iatrogenic effect, a side effect or disease caused by the “iatro,” the doctor.

Why do you focus on executive compensation?

Because I continue to feel that this is the elephant in the boudoir that we all want to pretend is not there and hope no one else points it out.

When our Conference Board Commission on Public Trust and Private Enterprise, co-chaired by John Snow and me, started our work in this area, I assumed that the widely reported, generic increases in executive compensation would present the major problem to the public. All of us on the Commission had read the BusinessWeek report showing that, over a 10-year period, compensation had risen about 9½ times faster for CEOs than for rank-and-file employees. We also knew that BusinessWeek had reported that in 1980 CEO compensation was 42 times that of the average workers, whereas in recent times it was roughly 500 times that average—far higher than in Japan and Europe.

We were also aware of critics who questioned management claims that employees’ compensation should reflect their productivity. These critics asked: Has management’s productivity grown that much faster than the average worker’s productivity? William McDonough, former President of the Federal Reserve Bank of New York, gave his direct and widely publicized answer to this question in a speech to the Trinity Church of New York, discussing the morality of the excesses of executive compensation: “I’m old enough to have known both the CEOs of 20 years ago and those of today. I can assure you that the CEOs of today are not 10 times better than those of 20 years ago.”

Clearly, this imbalance of pay between executive management and workers has contributed to the malaise in public trust. But as we delved further into this issue, I came to believe that the more dominant contributor to the loss of the public’s trust was the highly publicized reports of excessive and, indeed, egregious compensation of CEOs in failing or failed companies. A Financial Times headline read, “A Stunning Payoff for Corporate Failure.” A cover of Fortune magazine featured a story titled, “You Bought, They Sold.” The Fortune story reported that executives at certain companies whose stock prices had declined 75 percent or more from their peak in a relatively short period had nevertheless reaped billions of dollars of gains from stock sales. As the headline shouted, “Since 1999, Hundreds of Greedy Executives in America’s Worst Performing Companies Have Sold $66 Billion Worth of Stock.” In effect, the Fortune article seemed to be asking the Watergate question: What did they know and when did they know it?

Now, why do I believe that excessive compensation at these failed or failing companies—rather than simply the overall increase in executive compensation—is the more dominant explanation of the precipitous decline in the public’s trust?

So called “class warfare” no longer seems to be as powerful a political message as it may once have been in America. Many Americans believe that the American dream is a real possibility for them: Witness the interesting statistical anomaly that 20 percent of Americans believe that they are in the upper 1 percent in terms of income, and another 20 percent believe that they will be. Moreover, $20 million salaries for sports stars, if they perform, do not seem to engender anything comparable to the criticism or anger engendered by compensation of certain executives. Perhaps their success is seen more as something to be admired, along with the hope that they or their kin can someday achieve that success. How often has anyone heard a concern about Warren Buffett’s or Bill Gates’ financial successes?

In many of the recent scandals, the public witnessed certain executives reap unprecedented gains just prior to a time when their shareholders suffered huge losses, and many of their employees lost their jobs and at the same time saw their retirement savings suffer irreparable damage.

This was most visibly demonstrated and most highly publicized in the case of Enron. Dan Yankelovitch, the well-known public opinion expert, reported that Americans were particularly outraged and frightened by widely publicized reports that the restrictions placed on Enron employees selling their company stock held in retirement accounts during periods of rapidly falling stock prices were far greater than those placed on Enron’s executives. Employees and the public alike saw this phenomenon as still another example of a rigged system that favored executive over non-executive employees.

What do you believe needs to be done about executive compensation?

After the Commission’s extensive study and analysis, I came to believe in the following triad of principles for establishing effective compensation systems:

a)    A renewed focus on the long-term success of a corporation;

b)    A renewed focus on corporate operating performance—not simply on stock price performance, which can obviously be capricious. With this in mind, the Commission recommended that independent Compensation Committees should be unconstrained by industry median compensation statistics or by the company’s own past compensation practices and levels. Instead, we recommended that the Compensation Committee, with the concurrence of the Board, should establish performance-based incentives that reinforce the corporate performance goals approved by the Board (for example, return on equity, revenue and profit growth, cost containment, cash management, and, to some extent, non-financial objectives, such as quality goals); and

c)    A renewed focus on substantial long-term stock ownership, which, in turn, can validate operating performance; help serve as a driver of long-term corporate performance; and more truly align the long-term interests of shareholders and management. Jeff Immelt of GE has gone so far to report he does not intend to sell any shares until he retires.

History teaches us that stock prices do tend to reflect operating performance over the long term. But it also teaches us that stock prices and operating performance often deviate over the short term. Therefore, we believe that, whereas managing for stock price gains too often means managing for the short term, managing with an eye towards long-term operating performance is in the best long-term interests of the corporation and its shareholders, as well as its other constituencies, such as employees, communities, and customers—all of whom have a decided interest in the long-term success of the corporation. That is why I believe it is critical to focus executive incentives on the long term.

Our recommendations for longer holding periods for equity-based compensation and for substantial stock ownership requirements for senior management and independent directors fit directly into this context. Indeed, had just these two best practices been in place, we may have avoided a number of the recent corporate collapses that were accompanied by egregious short-term gains by executives of those failing companies.

Peter G. Peterson is Chairman and Co-Founder of The Blackstone Group. He is Chairman of the Council on Foreign Relations, founding Chairman of the Institute for International Economics (Washington, D.C.) and founding President of The Concord Coalition. Mr. Peterson is the Co-Chair of The Conference Board Commission on Public Trust and Private Enterprises (Co-Chaired by John Snow, currently Secretary of the Treasury). He was also Chairman of the Federal Reserve Bank of New York from 2000 to 2004.

Prior to founding Blackstone, Mr. Peterson was Chairman and CEO of Lehman Brothers (1973–1977) and later Chairman and CEO of Lehman Brothers, Kuhn, Loeb Inc. (1977–1984). He was Chairman and CEO of Bell and Howell Corporation from 1963 to 1971.

In 1971, President Richard Nixon named Mr. Peterson Assistant to the President for International Economic Affairs. He was named Secretary of Commerce by President Nixon in 1972. At that time he also assumed the Chairmanship of President Nixon’s National Commission on Productivity and was appointed U.S. Chairman of the U.S.–Soviet Commercial Commission, which negotiated comprehensive trade, Ex-Im credit, arbitration, copyright and lend-lease agreements.

Mr. Peterson was formerly a Director of Sony Corporation, Minnesota Mining and Manufacturing Company, Federated Department Stores, Black & Decker Manufacturing Company, General Foods Corporation, RCA, The Continental Group, and Cities Service.

Mr. Peterson is a Trustee of the Committee for Economic Development, the Japan Society and the Museum of Modern Art and a Director of the National Bureau of Economic Research, the Public Agenda Foundation and The Nixon Center.
Mr. Peterson is the author of several books, including Running On Empty: How the Democratic and Republican Parties are Bankrupting Our Future and What Americans Can Do About It; Gray Dawn: How the Coming Age Wave Will Transform America – and the World; Will America Grow Up Before It Grows Old?; and Facing Up: How to Rescue the Economy from Crushing Debt and Restore the American Dream.
He has been awarded honorary PhD degrees by Colgate University, Georgetown University, George Washington University, Northwestern University, New School University, the University of Rochester, and Southampton College of Long Island University.